What Happens When a Stock Market Rises on Hopes, Not Fundamentals

By Michael Lombardi, MBA Published : March 1, 2013

As the stock markets reach new highs, I see more and more optimism brewing in the U.S. economy. Let’s get this straight; the rising of key stock indices close to new historical highs doesn’t mean there is economic growth in the country.

Problems with the U.S. economy persist. Consumer spending, one of the main indicators of economic growth I follow, just isn’t there. I have repeatedly said in these pages that consumer spending is the backbone of economic growth in the U.S. as consumer spending makes up more than two-thirds of U.S. gross domestic product (GDP).

Please take a look at this chart:

This chart represents the difference in real personal expenditure quarter-over-quarter in the U.S. economy since first quarter of 2010. It’s interesting to note that the trend of consumer spending is sloping downward. Consumer spending increased $92.0 billion from the third quarter to fourth quarter of 2010. In the same period in 2012, it only increased by $51.8 billion.

According to a study by Interest.com, median income families in only one major city (Washington) in the U.S. economy can afford to buy a typical new vehicle. (Source: CNBC, February 27, 2013.) The average car cost was considered to be $30,500 in 2012.

And retailers in the U.S. economy, highly affected by fluctuations in consumer spending, are feeling the pressure. Sears Holdings Corporation (NASDAQ/SHLD) reported a loss in its fourth quarter of 2012. The company’s revenues fell 1.5% in the fourth quarter, and have been falling for six consecutive years. (Source: Bloomberg, February 28, 2013.)

Sears is not the only retailer hurt due to weaker consumer spending. Wal-Mart Stores, Inc (NYSE/WMT), known for its low prices, is struggling to bring shoppers into its stores as well. Sales for the retail giant only increased by one percent in the fourth quarter, well bellow analysts’ forecasts. (Source: Bloomberg, February 28, 2013.)

Sales for J. C. Penney Company, Inc (NYSE/JCP) also fell in the last quarter of 2012. The company reported comparable sales fell 31.7% in the fourth quarter, much more than analysts’ expectations (Source: Reuters, February 27, 2013.)

Remember, the last quarter of the year is often the best period of the year for retailers because of the holiday season. If retail sales go down during the holiday season, it’s not a bright picture for consumer spending in the U.S. economy.

Clearly, consumer spending and the stock markets are painting two very different pictures of the U.S economy. Bleak consumer spending is obviously a problem for the U.S. economy. As the stock markets reach new highs, I worry, because stocks are going higher on hopes, not fundamentals.

The health of the Chinese economy is deteriorating, and it will have a significant impact on U.S. economic growth.

Almost half of the provinces in the Chinese economy are expecting an economic slowdown. They are lowering their growth targets. According to Nomura Holdings Inc., 14 provinces in the Chinese economy have lowered their target for gross domestic product (GDP) this year compared to 2012, and 17 have left it unchanged. (Source: Bloomberg, February 27, 2013.)

The Chinese economy only grew by 7.8% in 2012, compared to an average 10.6% over the past 10 years.

In addition to this, the country is facing a slowdown in its exports. According to the HSBC Flash China Purchasing Managers’ Index (PMI), exports from China have decreased, resulting in the slowest factory growth level in four months. The PMI had a reading of 50.4 in February 2013, compared to 52.3 in January. (Source: HSBC, February 25, 2013.) Any PMI reading below 50 indicates a contraction in manufacturing.

The economic slowdown in the Chinese economy seems to be ramping up, and it’s affecting other countries as well. Take South Korea, for example; the country’s industrial production fell due to an economic slowdown in China and weaker demand from the eurozone. South Korea’s GDP grew by only two percent for 2012, which marked the slowest growth in three years. (Source: Dow Jones Newswires, February 27, 2013.) The central bank of South Korea also cut the country’s growth rate for 2013 from 3.2% to 2.8%.

An economic slowdown in the Chinese economy is something very important to watch.

Consider companies like NIKE, Inc (NYSE/NKE), and YUM! Brands, Inc (NYSE/YUM). These companies, among others, operate in the Chinese economy; but unfortunately, they showed weak results in their most recent earnings reports. (Source: Wall Street Journal, February 24, 2013.)

If the economic slowdown in the Chinese economy dwindles any further, U.S.-based companies will face issues, as their ability to earn income will weaken. Dear reader, we are already seeing companies cutting costs by reducing their workforce because of bleak product/service demand from consumers in the U.S. and elsewhere in the world. An economic slowdown in the Chinese economy will force further cuts.

The current, most-quoted unemployment rate in the U.S. is 7.9%. But that number will skyrocket if conditions in the Chinese economy become more severe than they already are, as the Chinese economy is the second-largest economy in the world.

What He Said:

“Starting two years ago I was writing how the housing boom would go bust and cause the U.S. economy to suffer sharply. That’s exactly what is happening today. From what I see happening in the U.S. economy, I’m keeping with the prediction I made earlier this year: By late 2007/early 2008, the U.S. will be in a homemade recession. Hence, I expect housing prices to continue declining, soft auto sales, soft consumer spending and a lower stock market.” Michael Lombardi in PROFIT CONFIDENTIAL, August 15, 2007. You would have been hard pressed to find another analyst predicting a U.S. recession in the summer of 2007. At the time, the stock market was roaring with the Dow Jones Industrial Average hitting its all-time high of 14,164 in October of 2007.